Some time back there was this interesting quote in the newspapers: “Onion Rs 65/kg, Petrol Rs 65/litre, Beer Rs 65!”, where in for the first time need, comfort and luxury demanded the same market price. That is assuming onions are still a basic need!
Inflation has been steadily increasing since the last quarter and touched 8.4% in December 2010. In fact the Reserve Bank of India (RBI) just recently revised its baseline inflation projection from 5.5% to 7% for March 2010. Interestingly the leap in inflation from November to December, about 90 plus basis points came primarily from rising prices of food and energy. According to RBI these were supply shocks which they had not anticipated and the revised projections for March now take into account the fact that inflation in prices of these commodities don’t appear to declining in the near short term.
Further, unlike earlier occasions, this food inflation is not driven by food grain prices or global prices. This time around the steep rise in prices of necessary goods like vegetables, fruits, milk, eggs, meat and fish, which get 10% weightage in the WPI (wholesale price index), is throwing the inflation beyond control. This was mainly fuelled by supply shortages in agricultural produce due to untimely monsoons and inadequate storage facilities.
Impact on financial markets
The recently published Investment Confidence Index survey report by JP Morgan and ValueNotes, emphasises the fact that inflation continues to be the biggest worry for the Indian retail investor. As per the study for this quarter (Oct-Dec 2010) amongst all categories of investors, corporates (63%) have been the most apprehensive about Inflation followed by advisors (48%) and retail investors (19%). This sentiment was clearly reflected in the recent stock market crash where the SENSEX fell from highs of 21,000 in November 2010 to 18,500 in January 2011.
Source: ValueNotes- JP Morgan Investment Confidence Index
According to the World Economic Outlook and the Global Financial Stability Report published by the International Monetary Fund, rising pressure on commodity prices is expected to continue this year because of ever increasing demand and a lethargic supply response. While government interventions such as bans on exports and reduction of import duties are likely to give momentary relief to consumers, the threat of rising inflation is likely to continue.
So what can be done to control this rising inflation? Some short term measures suggested by economists and policy experts are:
1. Curtail demand for superfluous products (e.g. tobacco, cigarettes, liquor) that raises governments’ healthcare costs & leads to underutilization of human resources or by using selective tax hikes.
2. Augment supply of goods & services by eliminating or reducing import duties and restricting exports of basic food products
3. Restrict money supply by using fiscal measures like withdrawal of stimulus & selective tax-hike
But a real long term answer to this problem is that the state should improve the quality of its expenditure and commit more resources to capital spending that would eventually simplify some of the bottlenecks that contribute to rising supply-side inflation. Tackling supply side constraints is the most important measure of restraining inflation. The two main long-term constraints are agricultural productivity and infrastructure like transportation & storage facilities.
Currently there are numerous projects in the pipeline to establish such infrastructure like roads, ports, storage facilities and freight stations. But there is a need to facilitate & expedite these projects. A well-organized storage & transportation infrastructure for agricultural produce will help in saving significant wastage and lower consumer prices.
Till we are able to tackle these supply side constraints, I think the rising inflation rate will continue to impact the market sentiments as higher inflation & tightening of the monetary policy could fuel further negative sentiments in the markets.